While the advent of Ethereum staking brought with it a wave of enthusiasm and innovation, giving birth to a thriving ecosystem of Liquid Staking Tokens (LSTs), it also highlighted a challenge. As the space expanded, it became far more fragmented, with countless LST protocols vying for a piece of the pie.
The sheer variety of LSTs, each with its unique token models and reward accumulation mechanisms, has left many users struggling to understand the rationale behind various token designs. At the same time, it's become harder for protocols to communicate their unique value amidst the noise.
Application builders inherently want to prioritize the category leaders due to the availability of liquidity, with marginal improvements in value, and this creates a “long-tail” of protocols that see minimal traction and TVL.
To compound this issue as time goes on, “late” entrants have an increasingly challenging time gaining traction and adoption through meaningful integrations and partnerships. As has happened in the past with BTC derivatives, the novelty of fresh ways to wrap a native asset soon loses steam - and while it can be argued that Ethereum’s LSTs have inherently longer staying-power, it may be inevitable that history repeats, leading to a far more centralized ecosystem with liquidity concentrated in a handful of protocols.
Pricing Stability: A Persistent Challenge
The lack of pricing stability between LSTs and against native ETH remains a significant hurdle. Despite all-time high liquidity, LSTs frequently suffer from mispricing or depegging. A prime example is the repeated depegging events with the ETH-stETH pool on Curve Finance. The lack of utility for this pool's LP token means the pegging of stETH is reliant on individuals deliberately exploiting the natural discount of one of the assets, offering minimal benefits for liquidity providers - nor any way for them to benefit from users engaging in arbitrage.
In contrast, LSTs like SETH2 maintain a stable peg due to UniswapV3's "concentrated liquidity" feature. This guarantees a 1:1 purchase ratio between ETH and SETH2, minimizing volatility. However, the low volatility results in reduced trading (as there is no way to arbitrage), consequently leading to lower fees for LPs. With no use-cases for this pool's LP token, there's no way for users/LPs to compound their yield, negating the value of "Liquid" Staking, and also generally resulting in dramatically reduced APRs without token incentives.
New Entrants and Unproven Models
Because the non-functional LP tokens of old aren’t able to maintain the “liquid” aspect of LSTs, we've seen recent developments in LSDfi with protocols that mint a secondary LST upon single-sided depositing of primary LSTs into a large multi-asset pool, and attempt to maintain a peg without any meaningful mechanisms. This model, while theoretically sound, is yet to be tested under the pressures of significant supply and demand cycles.
Other examples of models, like single token wrappers, have shown significant mispricing issues, with the peg mechanism seemingly reliant on the long-term conviction of holders/buyers. We’ll break down why tapETH’s model is by far the most superior when it comes to functionality, stability and security in an upcoming article - so keep an eye out.
The tapETH Solution
At Tapio Finance, we've taken these challenges to heart as while we believe in the potential of LSTs - we also recognize the need for a streamlined, user-friendly aggregator or middleware for this liquidity. Our “meta-LST”/LP token, $tapETH, standardizes the LSTs and native ETH into a single ETH-pegged asset, which is backed by various stablepools - effectively allowing users to provide liquidity, while also maintaining their ability to use the resulting token within DeFi.
As a result, LST protocols are able to have a means of ensuring downstream utility by simply utilizing Tapio as a dedicated liquidity pool between their own LST asset and native ETH. This not only means that the backing of tapETH becomes more diversified, but also ensures users of the LST have the best capital efficiency by being able to use tapETH within countless DeFi applications.
TapETH allows holders to enjoy the stability of holding native ETH while also benefiting from the yield and protocol fees associated with LSTs and providing liquidity. It maintains a stable peg against native ETH and standardizes the yield accumulation and reward distribution across different LST formats, and also facilitates low slippage and price impact swaps - making it the premiere place to swap ETH and LSTs, allowing for exceptionally favourable arbitrages and trading opportunities.
Unlike typical liquidity pools that only allow you manifest an arbitrage trade with a single swap - because tapETH is it’s own independent asset pegged to ETH, users are also able to redeem tapETH (to acquire additional discounted assets) or mint tapETH (for a discount by depositing assets with a premium), which also contributes to the peg of tapETH itself (which we’ll break down in a subsequent article).
We want to work within anyone within the LST and LSDfi ecosystem, and we call on anyone invested in the long term future of Ethereum and liquid staking in general to join us on this journey - follow us on Twitter and join the rest of the community on Discord.
A rising tide lifts all boats - JFK